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Investing

Changing My Investing Strategy – Part I

Past Strategies

I’ve had a number of strategies for investing over the years. Initially I was a property investor who planned to do a FIRE (Financial Independence, Retire Early) type approach to saving in order to buy 5 houses to rent, then give up the aggressive FIRE saving to live a normal life for 30 years until those houses were paid off so I could live off the rent.

The property market changed a few years into my plans, which altered my strategy as each year passed, changing from a strategy to buy and sell to retire, to a buy and leverage to buy stocks, eventually becoming too much of a burdon in the effort to do my tax returns and dealing with bad tenants, causing me to part ways with property and focus solely on stocks.

I then discovered Angel Investing, and have made significant gains investing a number of six-figure sums in a handful of companies in this arena, which has altered my retirement timeframes significantly.

With my retirement timeframe brought forward, I now need to change my investment strategy from investing in growth stocks that will eventually pay dividends in 5-10 years time, to a new strategy that will give me an income and security in my retirement, which will be either next year or the year after – though truthfully I haven’t decided if I want to work for a few more years to get more security, socialize while my friends are at work, or become mega rich (the later is possibly less interesting to me, unless it would facilitate some other interest, such as making a business out of some of my inventions – yes, I’m also an inventor!).

How To Make An Investment Strategy

Having a strategy is something often talked about, but not often explained. People new to investing will always say:

“My strategy is just to make a bunch of money.”

“Buy low, sell high!” – words often proclaimed by the least educated of investors.

“I will invest in shares until I have enough money to buy a house.”

New Investors

Actually to be fair, the last one in the list of quotes there is almost a strategy.

To build an investment strategy, you first need a goal. That goal will most likely be to buy a house or save for retirement, though it could be as simple as buying a car or saving for a holiday. In fact, I would suggest that everyone’s goal should be to save for retirement, and holidays, homes and cars are things that you include in your strategy as interruptions along the way.

Once you have a goal for your strategy, you need to do some financial modelling. This will tell you what you need to do in order to meet your goals.

To do a financial model, first work out how much money you’ll need to attain your goal(s). Then work out how much you can save, how much you’ll need to invest each year, and how much your investments need to grow to attain the goal(s) set out. You’ll need to do several of these models to model what happens if things go right, wrong or somewhere in between. You’ll need a strategy for each scenario (or at least a strategy to deal with the near term issues).

Once you’ve got your models sorted out, you should think about whether they are tolerable. Do they prevent you from having the sort of life you want? If so, perhaps you can make another model that has some compromise? Your compromise should not involve making your financial models rely on your situation becoming more fortuitous than you might realistically expect. Alternatively this might be the nudge you need to put in the effort to get that higher paid job.

Once you have your financial model, you should refine your investment strategy around this. There might be a few investment strategies that fit your models. For example, at for the past few years, my strategy was to save like crazy then put my savings into investments that will grow at a rate that does not require me to save any of my salary – which I then used as a giant leisure budget as compensation for my time spend saving. Of course this was balanced by a backup plan which involved my savings being redirected back to investing if things didn’t go to plan.

You should always have at least one backup plan.

In fact, not only should you have backup plans, but you should have multiple plans that phase in and out of existence as situations change, much like my car keys seem to when I’m looking for them.

My Investing Strategy For 2021

My goal remains the same, which is to retire, but my timeframes have changed significantly. Therefore my new goal is to invest in things that will:

  • Give me dividends within the next 1-2 years, every year. This basically means that I need investments that give me dividends now, which have a history of paying dividends, so I can be sure that they will produce dividends in 1-2 years.
  • Gives me security of income for decades to come. This means that I’ll need access to a pot of money that can get me through bad times, with possibly a Plan C in case that goes awry. This also means that I’ll need my dividend producing stocks to grow the dividend return at a rate higher than inflation to be comfortable, or come up with an alternative strategy such as buying growth stocks that may not pay dividends, but can be sold at a later date to cover the failings of my dividend growth stocks – not my preference. I will also need a significant amount of diversification such that the loss of a few stocks from my portfolio will not make my lifestyle untenable, or have a Plan D that makes my lifestyle less expensive while I save / work for enough money to replenish my position.

As I’ve written a lot today, I think I might write up the rest of my Investing Strategy for 2021 another day. In the next article of this subject I will cover my costs, how I plan to diversify and cover my risks, and my investing strategy for the coming year prior to the preparation for my retirement, which will involved divesting my holdings in companies and investing in dividend paying stocks (unless those companies start of pay reliable dividends backed by a policy in the Company Constitution).

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Investing

My Alternative To FIRE

I thought it might be nice on a long weekend to take a little time to write about part of my financial path, and share part of the story of how I came to be in the position after less than a decade of saving, to be on the precipice of retirement at just 38 (in other words, I’m capable of retiring now, but I’d be poor). More specifically, I want to share the alternative approach to FIRE that I came up with.

What Is FIRE?

You’ve probably heard of FIRE, which stands for Financial Independence, Retire Early. It’s a relatively new movement, the idea behind which is that you live minimally in order to save like crazy and retire early.

I think living minimally and saving like crazy is a great way to get a fast start to your financial goals. In other words: you have to invest; and in order to invest, you need a pile of cash; in order to get a pile of cash, you have to save; in order to save, you probably have to live minimally.

The bigger the pile of cash you have saved, the more significant the compounded interest will be on your investments, and the faster you will be accelerated towards your end goal.

The trouble with FIRE is that people sacrifice their lives to get to their goal, which I believe is counter intuitive if your goal is freedom rather than safety. It’s counter intuitive because when you safe hard, you’re probably not living. This means that you’re sacrificing your time now, to get more time later. Any older person will tell you that time is worth more when you’re young.

Every time you choose something, you miss out on something else.

Lewis Hurst

The trouble is, for every decision you make, you miss out on something else. You choose the chocolate cake, you don’t get the raspberry cake; you choose to lose weight, you don’t get the food; if you choose to save, you don’t get to buy things and experiences; and if you choose to buy things and experiences, you don’t get to save.

My Alternative To FIRE

I believe that there are a few ways to get rich, and if you’re investing, you first need to save. The trick is, once you have saved and are investing, you might not need to save.

Using financial modelling you can find balance between saving and living, in exchange for a slightly extended timeframe of your financial independence. With my alternative to FIRE, you can even live frivolously after a stint of saving, but before retirement.

My approach has been to aggressively save (I didn’t need to do a spending budget, but budgets works for some), then calculate my rate of saving (which I wouldn’t have needed to do if I’d budgeted) per month / year. Then I started investing my saved money, at which point I calculated my Return On Investment (ROI) per annum. I then used financial modelling to work out how long I’d need to save for at my current ROI to get to my retirement goals.

In doing my financial modelling, I ran various models to see what happened if I adjusted the amount I saved each year. I noticed that the more money I had, the less my saving affected my retirement goals, to the point where (in later years) saving had no effect whatsoever.

I realised that I was able to save enough to get the benefits of compound interest from my investing activities, which meant that I could use the salary from my job 100% for my own enjoyment – which leaves a big entertainment budget and still gets my to my retirement goals earlier than I otherwise would.

Modelling at which point in time (age) I started to rely solely on ROI from my investments enabled me to make decisions about how early I could stop saving and start living my life the way I wanted to. Rather than sacrifice all my years saving before retirement, I could decide what was an acceptable amount of my youth to sacrifice in order to have freedom at an older age.

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Business

Model Everything: Capitalized Costs

Welcome to the first of my Model Everything series of articles. In this article I will be talking about the financial term called Capitalized Costs and how it can be used to model the profitability of ventures better.

What Is A Capitalized Cost?

A capitalized cost is essentially a cost that is displayed as it’s amortized value of the period of time, rather than a one off cost.

For example, if you buy a server for $20,000, and you expect to amortize that cost over 4 years, the capitalized cost would be marked as $5,000 a year over 4 years instead of a one off cost of $20,000.

Actually, it would probably depreciate differently over that period, but that’s another discussion.

Financial Modelling With Capitalized Costs

I like to capitalize costs when exploring the profitability of a venture because it prevents the delusion of profitability when there is none. In other words, you may not be making the profit you think you are because your capital expenditure costs are not included.

For example, you buy a server for $20,000 to host a web based product. Your first year isn’t profitable because you had hardware to buy. The second year is profitable and so is the third and forth year. you think you’re doing well until your fifth year when you realize that you have to re-buy the hardware you bought in year one because it’s old and needs replaced. Suddenly you’re not profitable again. Has the business really been profitable all those years?

Modelling profit using capitalized costs lets you work out the true cost, though I would recommend depreciating the cost evenly throughout the years for the purpose of simplifying your modelling (but obviously depreciating the assets as much as you can for tax purposes outside of your modelling).

Summary

You need to model the amortization into your cost planning, and that’s what cost capitalization does.

Nothing lasts forever, so it’s better to view everything as if it was effectively rented each year when trying to work out if a venture is profitable.

I hope that gives some food for thought and is useful.

Categories
Business

Common Mistakes Startups Make

I Am Starting A Business So I Need A Website

This is something that I used to hear all the time from people starting businesses, back when I used to run an IT company. They would come up with an idea, or have the beginnings of a business but didn’t feel that they had a proper business without a website. I believe that this is a logic fallacy stemming from the line of thinking that because successful businesses have a website, you need a website before you can be a successful business.

Now I’m not saying that you shouldn’t have a website. To be clear, I absolutely think you should have a website for your business. However (unless your business is focused around web business), you should be aware that it’s probably one of the least important aspects of a business.

The second thing about websites that I’d like to dispel is the idea that a website will get you lots of free business. It won’t. For a website to get traffic, you need to advertise the website. You also have to build a method to convert sales. This is beyond the scope of this article, but the takeaway is that a website is not what makes a business.

Religion, Babies, Politics And Pets

What do religion, babies, politics and pets have to do with business? Absolutely nothing, and it should stay that way! A big mistake that people make when producing public facing materials for their business is to include these things. I can tell you that there is no faster way to half your customer database than by pressing a political or religious allegiance. It’s just not necessary and will cause you to lose customers.

Another common mistake people make is to pick the thing they love the most in this world and expect that others will have the same positive feelings when they see baby pictures all over their website or their cute dog on their marketing material. Don’t do it! Resist! It’s a great way to instantly lose credibility and make you look like an amateur.

Not Measuring Effectiveness

Not measuring internal success of a business is a very common mistake. People often let the jubilation of all the sales coming from that big trade show hide the fact that it just wasn’t efficient – the event cost $3,000 to attend and you made $5,000 profit, but you forgot to add in the $3,000 of staff time to prepare and attend the event, support costs of the new sales, amortization of the event equipment, etc. When you consider all the costs associated with those new sales, the venture was not profitable.

Another common mistake is not measuring the cost of advertising. How do you know that the radio advert you paid for returned a profit? Did those new sales come from the radio advert or a Google search? People often pass off the cost of advertising as soft benefits and say that you can’t measure the value of having the brand out there. Another argument is that sales often come from multi touch points so you can’t measure the value of any particular media. For example a customer heard a radio ad and decided to buy when they saw a flyer from the company they felt they knew because of the radio ad.

There’s certainly some truth in this, but you should be doing your best to measure it. Ask customers where they’ve heard of you; give them discount codes that relate to particular adverts; if you’re big enough, create a new phone number, website or URL to monitor the success of that new TV ad. Organize your advert campaigns so different media over lap and measure the success of a campaign that includes multiple media types rather than a particular advert.

Measuring the effectiveness of your adverts is important because this will make your business more efficient. If your business is more efficient, your products can be cheaper, and if your products are cheaper you can be more competitive, put more money into efficient growth and be more resilient in a downturn (imagine your competitors indiscriminately cancelling TV, radio and web ads because they’re trying to save costs, while you know exactly what’s earnings accreditive and shouldn’t be cancelled).

No Financial Modelling

You see an opportunity to grow the business at the cost of raising capital from an external source. You could get an investor. You could get a bank loan. You could do nothing for a year and grow organically.

This decision is often made with feeling rather than with maths. For example, people don’t want to get more debt so they get an investor and lose a percentage of their business. Some people don’t want to lose a share in their business, so they do miss out on the growth.

Financial modelling is the best way to work out what course of action would result in the largest gain in the value of your share in the business. Financial modelling should be used throughout the business, including working out how a change (voluntary or otherwise) might effect the business.

As time goes by, I’ll add more articles about these subjects with more detail on each subject. Stay tuned.